This week a major case was settled involving counterfeit goods in China. In March, a tip led investigators to raid a small factory on the country's east coast and discover over 32,000 counterfeit Zippo lighters. Pennsylvania-based Zippo Manufacturing Co., maker of the American staple of cigarette smokers, survives on its brand name and has been furiously fighting counterfeiters for years. Needless to say, the company's management was thrilled to hear that the Chinese-based factory manager Mr. Zheng was going to go to court for punishment. Little did they know that the sentence would turn out to be a win for counterfeiters nation-wide...

When Mr. Zheng walked out of the courthouse this week, he carried with him a fine roughly equivalent to $12,500. A mere slap - no, tap - on the wrist. Meanwhile, at $25 a pop, Zippos looked at the 32,000 counterfeits as having a price tag of $800,000 in revenue. So why did Mr. Zheng get off so easily?

According to Chinese law, the seriousness of a crime is measured by the profits that the counterfeiter would have made. This is in contrast to US law, which tends to look at both the profits made by the guilty counterfeiter as well as the damages to the plaintiff, which are often measured by the plaintiff's lost profits. In the Zippo case, Mr. Zheng's price to his distributors was proven to be about 37 cents per lighter. And there we have the disparity.

Not only do China's valuation methods create large differences in what are perceived to be approprite fines, they also create safe havens from jail time. Cases are organized by tiers in China such that those involving sums less than 50,000 yuan rest in "administrative" courts and are disallowed from including jail time as punishments. In many cases these disputes don't even get scrutinized by the police.

For this reason, counterfeiters are hardly discouraged from continuing their business. A fine like $12,500 will not knock out Mr. Zheng's factory, and most likely he will reallocate his resources to yet a new counterfeit product in the near future.

This flaw in China's legal system has created a huge problem for the country. It is estimated that between 15 and 20 percent of Chinese goods are counterfeit. Imagine if one out of five dollars you spent was on fake products.

A couple of years ago 60 Minutes did a show where a crew travelled to a few towns in China known for their counterfeiting madness. They found full factories dedicated to making fake Callaway golf clubs; entire shopping malls filled with name brand stores - none of which were real; and even Harry Potter books that were written by authors other than J.K. Rowling.

Chinese policemen have therefore been quoted as saying that they are easy on counterfeiters so that they don't produce social unrest. The problem has gotten so out of hand that the livelihoods of entire communities depend on the production and sale of counterfeit goods.

The Zippos case was yet another win for the counterfeiters. Until Chinese lawmakers decide to make sentences for the guilty punitive, the industry will not cease. And even though China's GDP is benefitting heavily from these operations, it is in the country's best interest to change. Counterfeiting will continue to be a significant barrier to foreign investment, as CEOs of foreign manufacturers won't be able to sleep at night knowing that a patented mold in their Chinese auto plant could be so easily stolen and plopped into a counterfeiter's factory down the block. In addition, fake goods carry with them no warranties, health standards or other controls that prevent malfunciton and serious harm to consumers.

But, as with many problems in economics, the consumers often make the law. As long as there is demand for counterfeit goods, the counterfeiters will win. The cheap smokers out there may get utility out of their 37 cent lighters in the short term, but what happens when Zippo Manufacturing goes broke? Won't the allure of their fakes fizzle too?

Posted by Michelle Smith on June 3, 2006 06:46 PM

Posted by: Amanda at August 18, 2006 10:10 AM